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Fed Should Do Less, Not More, to Avert Another Calamity

Written by: Peter Morici02/04/13 - 7:30 AM EST

NEW YORK ( TheStreet) -- It's time for the Federal Reserve to do less to prop up the recovery and jobs creation.

The economy suffers from too little demand. Simply, the huge trade deficit with China and on oil sends too many consumer dollars abroad that don't return to buy U.S. exports, goods and services.

During the Bush years, Americans artificially boosted demand by spending more than they earned, borrowing recklessly against their homes, on credit cards and for college educations that proved poor to be investments. Ultimately, failing loans sank financial markets.

Meanwhile, other problems festered. Health care costs and university tuition rocketed, longer life expectancies undermined Social Security, and states borrowed too much.

When the president campaigned in 2008, he promised to get tough with China on trade and produce more oil. He has done little about the former, and in the wake of the Deepwater Horizon disaster, he punished an entire industry for BP's (BP) sins by curbing drilling offshore and in Alaska.

He dramatically increased federal spending on entitlements, made student loans even more accessible and eschewed the recommendations of the Simpson-Bowles Commission to raise the retirement age.

With federal deficits exceeding $1 trillion for five years, Mr. Obama faces the same skeptical bond rating agencies that downgraded European government debt.

The Congress shares blame in its unwilling to address honestly trade, energy, health care and education.

The Federal Reserve became an enabler of Presidential and Congressional inaction by keeping interest rates artificially low for five years, and now by printing money to buy U.S. bonds and mortgage-backed securities at a $1 trillion annual pace.

Record low interest rates are propping up weak consumer demand but sowing the seeds of another financial crisis.

Easy money is again pushing to unsustainable prices for real estate in prime urban areas and boom towns, agricultural land and the bonds of weaker corporations. And cheap borrowing rates help banks push student debt to more than $1 trillion, even though one in six loans is in default, and permit California, Illinois and other states to avoid reforming pension systems and issue debt they never will repay.

Inevitably, all that money will push up inflation, and then the Fed will be compelled to stop buying bonds and let interest rates rise to levels the federal and state governments can't bear easily.

The federal and state governments will be forced into draconian spending cuts in the manner of Italy or Spain, corporations and state governments will default on many of their lower-grade securities, and higher mortgage rates will drive down real estate and agricultural land values, creating a new round of mortgage defaults. Former students overburdened with debt won't be able to manage daily living expenses and simply will default.